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Silicon Alley 2.0Crash Reboot Relaunch

While Silicon Alley is still paying for its first-round excesses, the smart money is primed to get back in the ring. But don't call it a dot-comback: the new contenders come from geekier stock. Can you say "distributed computing"?

As founder of flatiron partners, Fred Wilson runs almost half a billion dollars of the smartest money in town. A great deal of it is parked in technology start-ups -- New York ones. But up in a conference room that overlooks Gramercy Park toward the East River, Wilson is admitting that, despite a peerless network of contacts and fourteen years of venture experience, he's perplexed by what's happening in Silicon Alley. The pendulum has swung too far. * "We've gone from a period where there was stuff I didn't understand on the overinflated hype side to where we're seeing stuff I don't understand on the negativity side," says Wilson, settled into one of the ten or so gray rolling chairs that fill the cubicle-size room. Sure, nasdaq is crashing, the IPO market is DOA, and dot-coms are shutting down and scaling back daily. But "when people start throwing in the towel on good businesses that make sense" -- off the top of his head, he mentions vitamin e-tailer Mothernature.com ("a replenishment business; should be great for the Web") and electronic-invitation site eVite (with tons of traffic, wouldn't a portal buy it eventually?) -- "I take that as the sign of a bottom."

When smart money senses a bottom, it starts buying, and, at Flatiron, the shopping has already begun. "I now feel tangibly for the first time in six months that everyone here is saying, 'We've got our house in order; let's go out and find some deals to do,' " says Wilson. "And if we're starting to do it, other people are starting to do it, too."

Fast, fat, and heavily hyped, New York's late-nineties tech boom was in many ways a flash in the pan. But as with any gold rush, it made a lasting mark on the surroundings. Venture capitalists, programmers, and digital-media firms -- the Internet equivalent of banks, miners, and general stores -- have staked out their territory and are here to stay. "Whatever ups and downs we've gone through -- and millions were created and wiped out -- one thing all that did," Wilson professes, "was to create a base of entrepreneurs and people who understood how to work in and finance small companies. That's been woven into the New York economy forever."

Despite its sharp downturn, Silicon Alley has joined Wall Street and both Seventh and Madison Avenues as a convenient, if inaccurate, geographic shorthand for one of the Big Apple's core businesses. When the history writers tackle turn-of-the-century New York, the extravagant catered launch parties and in-house masseurs will be mere footnotes in a chapter about the city's emergence as a world-class high-tech center.

Like every other fixture of the city's economy, Silicon Alley will cycle between boom and bust. "There's a lot of VC money sitting on the sidelines right now, because no one wants to be too early," Wilson admits. The question is what it will take to get that money off the bench and into the game.

"People in New York are smarter than they are in California," says the recently transplanted CTO of a local start-up. "Silicon Valley is just dense with geeks."

"After the New Year, with a new president and the 2000 crash consigned to the past, there'll be a lot of money flowing again," says David Bennahum, a former tech journalist turned partner at New Things Ventures, a fund that invests exclusively in wireless companies.

Some think the tech sector has already begun to bounce -- "the bottom was about three weeks ago," dot-com buyout specialist Scott Hyten told Web M&A Update, an industry newsletter, in mid-December. Others believe a turnaround will take longer, and that the Alley will continue to suffer in the interim. Either way, venture-capital funds will need to start putting their money to work. Investors put so much money into tech-venture funds over the past couple of years that when VCs cut back the flow in the spring, their cash built up like water behind a dam. Now there's pressure on them to release it downstream to start-ups; since their profit comes mainly from their investments' return, they can't earn much, or grow, unless they spend what they have and raise even more.

When the VCs reopen the floodgates, they could actually shower as much, or more, seed capital on the local economy as they did during the boom. According to Robyn Beresh, a researcher at Asset Alternatives, a VC-industry research firm, New York City-based venture firms raised more than $43 billion in 2000 -- 30 percent more than in 1999. "Historically, VCs tend to invest close to home," notes DoubleClick CEO Kevin Ryan, for the simple logistical reason that it's easier to keep tabs on what your money's doing if you've parked it across town instead of across the country. While Flatiron and newer New York firms like RRE Ventures do fund California deals, they prefer to keep as much of their portfolios as possible a cab ride away.

The local venture scene has also begun to get its act together, literally. In the Valley and around Boston, top firms such as Benchmark and Kleiner Perkins routinely cut deals in syndicates. One lead firm does most of the homework, sets the pricing terms, takes a board seat, and brings other VCs in as financial partners. This spreads out risk and builds relationships among firms, and gives them bargaining leverage as well. But New York venture money, with its roots in rivalrous Wall Street, is only beginning to work that way. "We started out as competitors," Wilson observes. "Now we're realizing we should be collaborators."

"Because of Wall Street and the law firms, there was a tendency to overlegalize things," recalls John Borthwick, who sold Total New York to AOL in 1997. "People used to say to me, 'Out West you can get a deal done, and back here you have to go through 50 lawyers.' " Now head of AOL's 18th Street-based new-product-development team, whose activities include acquisition-hunting, Borthwick believes the past two years' trial by fire has brought the city a class of financiers and executives experienced in the Internet's speed and collaborationist style. The upshot: As local VCs begin to gang up and bargain collectively with promising start-ups, it will be harder for the city's entrepreneurs to exact massive 1999-type valuations. But it should also enable more deals to close.

Besides a few personal fortunes, and a lot of promotional T-shirts and mouse pads, the most important legacy of the Silicon Alley bubble will be an infrastructure -- of bandwidth and hardware, but more important, of people. No, New York isn't going to trump the West Coast's overall technology dominance -- there's way too much space, talent, experience, and academic firepower in the Valley for New York to mount a serious challenge in more than a few sectors. Yet technology remains a major engine of growth here -- the biggest new segment of the local economy in decades. "Silicon Alley isn't just some content and e-commerce guys now," insists New York City Investment Fund president Kathryn Wylde. "In only four years, it's become a very rich environment."